Episode 11: The Lopsided Recession

TESS VIGELAND: The coronavirus outbreak dealt a swift shock to the global economy, one more severe than the 2008 financial crisis, and perhaps even the Great Depression.

EDUARDO PORTER: And the lockdowns have now led to a unique sort of recession which is hitting different parts of the economy at different speeds.

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TESS VIGELAND: This is Pandemic Economics, a podcast about the global impact of COVID-19 from Stitcher and the Becker Friedman Institute for Economics. I’m Tess Vigeland.

EDUARDO PORTER: And I’m Eduardo Porter. We’ve been invited to have conversations with University of Chicago economists. In this episode, I talked with Erik Hurst and Veronica Guerrieri of the Booth School of Business about the lopsided nature of the pandemic recession.

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TESS VIGELAND: Eduardo, we’ve been talking about this lopsided nature since the pandemic began. It really has been incredibly unequal effects across the board.

EDUARDO PORTER: Absolutely. And this is very unusual. It’s different to your garden variety recession. This is something that hit specific sectors of the economy basically because of a health shock.

TESS VIGELAND: Right. And so we’ve talked in previous episodes about how this has hit people unequally based upon whether they can work from home or not. We’ve talked about this hitting women more severely than men. So what are we going to hear from Veronica and Eric today?

EDUARDO PORTER: Well, Veronica basically has developed a model that walks us through how the impact of the health shock to certain sectors of the economy is going to cascade through to the rest.

TESS VIGELAND: So it’s kind of a waterfall effect, then.

EDUARDO PORTER: Yeah. And then Erik Hurst shows how clearly the pattern of joblessness fits into this story that Veronica has developed.

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So, like your, normal recession which comes when, say, the Federal Reserve increases interest rates and borrowing becomes more expensive, is people stop spending, and that pretty much affects businesses across the board, right? There’s no particular sectoral composition. Yeah, and this is not true in this case.

VERONICA GUERRIERI: Exactly. So the direct effect of the shock is basically a shutdown in some of the sectors, either because of lockdown policy or because people are scared, and don’t want to go and consume in a given sector or work in any given sector. But the result is that some goods and services are not produced.

So you don’t want to really have people go into the restaurant too much. You don’t want to really have people going travel too much. But on the other hand, you would like to have people consume other goods that are produced and they’re consumed without having too much social interaction– for example, online retailers.

And so here is why even though that type of shock may be thought as more of a supply shock because it hits some sectors but not others, you can have still demand shortages in the other sectors. And so you can have expansionary policy helping the economy to recover.

EDUARDO PORTER: And Erik, in fact, this kind of asymmetry has shown up in your data, too, right?

ERIK HURST: Yeah. I mean, just as Veronica said, the biggest employment losses are in industries for which social interaction is important. So think about restaurants, and hotels, and bowling alleys, and barbershops, and things where people have to be in close proximity to each other. Employment there fell almost by 40-some percent in some of those sectors from early March through late April.

And, you know, other sectors like finance, where you don’t have to interact, people could work from home, employment there only fell by about 4%. So you see that same type of heterogeneity that’s at the heart of Veronica’s model in the data.

VERONICA GUERRIERI: So why the shock hit one sector, which is high contact intensive and then propagate to the others? It may be either because the other sector produces a good that is complementary to the first one that has been shut down. So, for example, restaurants close, there may be some sectors that get a little bit of a bump in demand.

For example, takeout food. But there are some sectors, like, for example, clothing online that may have a drop in demand because people are not going to buy so many fancy clothes if they don’t go out for dinner. And then on top of that, you’re going to be also seeing the other effect coming from the loss of income of the workers in the sector that are hit directly. And so you can see the impact of that on demand, too.

EDUARDO PORTER: OK. So you’ve got the drop from the income of restaurant workers. It kind of disappears, and so they stop consuming because they’re out of a job. You have the drop in demand for things that are complementary to restaurants, as you said, like fancy clothes. And then you have the drop in the stuff that the restaurant might buy, linens, or software systems for managing reservations, or whatnot. So you have various channels how this could propagate.

VERONICA GUERRIERI: Exactly.

ERIK HURST: Yeah. I mean, what is fundamentally different about this recession relative to others is the shock itself. And the shock itself is a health shock. And when people say, when are we going to get back to normal, the answer is, not until well after the health shock has been solved. And so that is the fundamental shock.

And as Veronica said, people don’t want to go to restaurants with the same veracity or take trips on the planes with the same frequency unless some sort of vaccine or extreme mitigator of the adverse health effects from the virus takes place. And a lot of what we are talking about is, can we keep some of this institutional capital in place until a vaccine?

EDUARDO PORTER: Right. We need businesses to stay afloat and to protect workers’ income, right? Ensure that when we have a vaccine, say, and people are willing to fly again, we’ll have airlines, and pilots, and everything else that’s needed to do the job.

ERIK HURST: Exactly. I imagine once vaccine comes, we will feel pretty safe. But it’s how long it takes for that to happen, and how do we manage the transition? Because I don’t think New York City restaurants, or Chicago restaurants, or any restaurant could maintain at half capacity or one-third capacity and make their rent payments for long periods of time.

EDUARDO PORTER: Yeah, yeah. Let’s move a little bit to the policy response, because the policy response, of course, has to be different given the difference of the shock. How would you rate what we’ve seen so far?

ERIK HURST: I’m not very good at grading, but I can at least say that we understand that the shock is a health shock. The cost in the long run accumulates from the destruction of this institutional capital. And the policy so far has been trying to maintain some of that institutional capital.

It’s nowhere near like in prior recessions, where you want to bring us back to prerecession levels. Economic policy cannot bring us back to prerecession levels until the health shock is cured. And so what they’ve been doing now with policy is trying to maintain a little bit of the institutional capital until we can get to solve the health crisis.

EDUARDO PORTER: Yeah. You point this out in your paper, Veronica, that one cannot see this as demand stimulus across the board because of the supply constraints.

VERONICA GUERRIERI: What we are saying is that the standard type of fiscal policy that are across the board, of course, are less effective– are still positive, because whenever there is some lack of demand, that any stimulus is welcome. But they are less effective than more targeted type of policies that aren’t going to directly hit the part of the economy that cannot be brought up by standard government spending policy.

Because the problem is that the standard government spending policy typically is beneficial not only because they radically help by increasing the spending in the sector, but typically help generating more jobs and give more jobs to the people that lose their jobs.

But in the current pandemic event, you cannot give the job back to people who work in restaurants or work in sectors that are hit by the health shock. And so that’s where insurance is important.

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EDUARDO PORTER: Coming up, will it all get better once we find a vaccine?

TESS VIGELAND: Stay with us for more Pandemic Economics in just a minute.

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EDUARDO PORTER: In this rebound in employment that we saw in your latest reading, is it the industries that lost jobs are the industries that are rehiring jobs? Or is there any evidence of some sort of reallocation that might be interesting to look at?

ERIK HURST: I mean, so the answer is there’s always reallocation, even in non-recession types. And some of that’s still going on now. During the recession, about 10% of businesses grew by at least 5% to 10% of employment. So there are some sectors out there that are growing, and that always is the case.

What’s different is 90% of the businesses either were stagnant or shrunk, so there wasn’t a lot of growing in any sector going on. And during the recovery, a lot of the recovery was in the sectors that shuttered temporarily. Now, some of those sectors are things like manufacturing.

Non-essential manufacturing closed and then opened up. And in almost all states, that happened. So you’re seeing rebounds in employment in construction and manufacturing across all states. And then you’re seeing in some places, rebounds in employment in restaurants, and nail salons, and barbershops, and beauty parlors.

And those increases have occurred more, not surprisingly, in the states that opened up those sectors earlier. So even in the states that reopened these sectors, employment in these sectors are still severely depressed– not quite as depressed as they were in April, but still severely depressed relative to where they were in late February.

EDUARDO PORTER: By the way, another margin of adjustment that we haven’t talked about but that you found in this recent paper is the drop in nominal wages for, I think, one in 10 workers, presumably will lead to less unemployment, because rather than fire folks, employers will just reduce wages?

ERIK HURST: Yeah. I mean, adjustments will occur at all margins. But for those who are remaining employed, wage growth is muted. There are a lot more people who are getting wage freezes, even relative to the Great Recession, and much more people getting wage cuts, even relative to the Great Recession, in the last three months.

About 10% of workers who were you know scheduled to be on normal wage adjustment patterns got wage cuts in the last two months or so. And only about half of those workers got a wage increase where normally on your regularly scheduled wage time, about 75% to 80% of workers get a wage increase.

So you’re starting to see less wage growth, which is going to be one thing that’s going to be with us for a while. Even those of us who are employed are going to see lower wage growth than we would have otherwise had it not been for the virus.

EDUARDO PORTER: My closing question would be to ask you to look into the future and to tell me, how do you see this evolving? Is this going to be a bounce, a rapid bounce like a V-shaped recession, or is it going to be more of a longer slog?

VERONICA GUERRIERI: I am positive that a vaccine or a cure is going to be found at some point in not the near future. And so I expect that when that will happen, we will have a pretty fast recovery. For sure, we will have a big jump up in economic activity and a dramatic improvement of the situation.

We are not maybe going to go back immediately to where we were before. And this is because the loss of income of many households, the need to borrow, and the increase in households’ private debt is going to generate some slack in the capacity of spending of these households.

And so it’s going to take some time to recover, and so we are going to see part of that. But that is going to be a component, of course, of this huge shock that is going to disappear as soon as the health emergency is going to go away. Now, what’s going to happen from now until health emergency disappears, meaning until a vaccine or a cure is going to be introduced?

Well, I’m afraid things are not going to be very good. I think that we’re going to see a little bit of probably back and forth, and a little bit more increase in real activity, and then maybe possibly a second wave of the virus is going to slow down things again. And so we are still going to be on this emergency safety situation where I think social insurance policy is very important. That will help.

ERIK HURST: Yeah, well–

EDUARDO PORTER: This thought might be totally off the mark. It was riffing off of the idea of Veronica’s paper of a supply shock leading to demand shock. I was thinking, OK, what moment in our history might I be able to compare this to? Is there anything to learn from the stagflation moment of the ’70s when we did have a supply shock from the oil embargo and we had a demand shock, too?

VERONICA GUERRIERI: There is a big difference between the ’70s and now. And the big difference, again, that even if you want to think that the shock is really a pure supply shock to start with, this shock hits only some sector in a direct way. And that’s where our demand shortages come to the picture, and was not in the picture in the ’70s.

So in the ’70s, expansionary monetary policy were harmful, because they were just generating inflation and not helping and increasing economic activity. Right now, because of the demand shortages in sectors that have not directly hit by the health emergency, expansionary monetary policy is only beneficial because stimulating demand is what you want to do wherever you can do it.

And so we should not be worried about inflation right now. In fact, we have seen that inflation is going down in a steady way in the last months. And this is exactly the sign of the slack in demand that I’m talking about.

There is not enough demand for those goods and services, even the traded ones, so the ones that were not in the sectors that were either locked down or more high-contact intensive. And so this comparison highlights very well why this shock is very different from the past and why it’s important in terms of policies to think about these differences.

EDUARDO PORTER: Erik, so I wanted you to revisit your thought from our last conversation. Do you still think we’re going to get some continued job gains now as we reopen to take us some way back?

ERIK HURST: Yeah, some way back. The key thing is that the original prediction, I still believe, and let me just restate it– that the job losses that we saw between March and April in the US were historic. We lost 20% of employment. That puts us at Great Depression levels at a very short frequency.

And what I predicted and which we’re seeing is we’re going to see some rebound in that employment as we start opening up sectors and starting to figure out some way to live with the pandemic. However– this is the key part– even with large– and I went even further– and said massive employment growth during the summer, I still predicted we’d still be somewhere between 10% and 8% to 12% lower than we were in February.

Just as with perspective, that’s employment losses worse than the Great Recession. So we were still going to be in a massive historic recession, even if we had large employment growth this summer.

And I think both things are going to be true. And so we’re going to get to the summer, we’re going to settle in at employment losses that are going to be worse than the Great Recession, but nowhere near as bad as they were in March and April. And that is going to be our reality until the health crisis is over.

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TESS VIGELAND: A lot of that potential employment growth that Erik mentioned will depend on people returning to at least some semblance of normal economic activity. But it’s not as easy as states lifting lockdown orders.

SPEAKER: Anything you can do to make clear to people, we will help you not to catch the virus if you come here. We’re not going to put you guys too close to one another. We have good ventilation, we have screens between stalls, whatever it might be– our results at least suggest that things you can do to make people feel more comfortable are probably good for business.

TESS VIGELAND: Next time, we’ll explore research showing that people are making their own decisions about safety, regardless of what the government tells them. Pandemic Economics is produced by the University of Chicago’s Becker Friedman Institute for Economics.

Our producers are Devin Robins and Dana Bialek. Our executive producer is Ellen Horne. Production and original music by Story Mechanics. Pandemic Economics is part of the University of Chicago Podcast Network. I’m Tess Vigeland.

EDUARDO PORTER: And I’m Eduardo Porter. Thanks for listening.